Unit 3
Unit 3
ELASTICITY OF
DEMAND AND SUPPLY
In this chapter
Concept and types of Price, income and cross
elasticity of demand, Measurement of Price, income &
cross elasticity of demand: Total outlay, point & arc
method, Used of price, income and cross elasticity,
Concept of elasticity of supply, Measurement of
elasticity of supply (numerical exercises
Elasticity of demand
Introduction
• First Announce by: Cournot and J.S. Mill and developed
by Marshall- "Principal of economics"
• The word elasticity means flexibility.
• Elasticity of demand is the measure of reaction of quantity
demanded to the change in its` determinants.
• A measure of responsiveness of quantity demanded to
the change in its determinants is known as Elasticity of
demand.
• "The elasticity of demand in a market is great or small
according as the amount demanded increase much or
little for a given a fall in price and diminishes much or little
for a given rise in price." -Marshall
Types of Elasticity of Demand
• There are as many elasticity of demand as its
determinants. There are mainly three types of elasticity of
demand as pointed.
• Price Elasticity of Demand
• Income Elasticity of Demand
• Cross Elasticity of Demand
Price Elasticity of Demand
• Price elasticity of demand is the measure of
responsiveness of quantity demanded to the change in
its` Price.
• Price elasticity of demand is the define as the ratio of
percentage change in quantity demanded to the
percentage change in its` Price.
It can be expressed as:
Cont…………….
• Symbolically,
Where,
Ep=Price elasticity of demand
Q= Initial Quantity demanded
Q= Change in quantity demand
P= Initial Price
P= Change in Price
Types(Degrees) of Price Elasticity of Demand
Ep=
D
Perfectly Inelastic Demand (Ep=0)
• Symbolically,
Where,
Ep=Price elasticity of demand Q= Initial Quantity
demanded
Q= Change in quantity demand P= Initial Price P= Change
in Price
Total Expenditure(Outlay) Method
• Develop by Marshall
• Compare total expenditure in different prices
• It does not gives value of Ep
• It can be known whether the demand for
commodity is elastic, unitary or inelastic.
• Total outlay= Price x Quantity demanded
• If Ep>1 it means total expenditure increase with
fall in price and decrease with rise in price
• If Ep<1 it means total expenditure decrease
with fall in price and increase with rise in price
• If Ep=1 it means total expenditure remain
constant with fall in price or rise in price
Point Method
• Develop by Marshall
• It measures price elasticity of demand at a point
of demand curve
• It measures the proportion change in quantity
demanded in respect to a very small proportion
change in price.
Where,
EY=income elasticity of demand
Q= Initial Quantity demanded
Q= Change in quantity demand
Y= Initial income
Y= Change in income
Types of Income elasticity
• Symbolically,
Where,
EY=income elasticity of demand Q= Initial Quantity
demanded
Q= Change in quantity demand Y= Initial income
Y= Change in income
Arc Method
• If we calculate income elasticity as coefficient of
demand between two points on a demand curve
is called arc method. This method is used when
there are large change in income and quantity
demanded.
• The formula for measuring income elasticity of
demand at the middle point of the arc on the
demand curve is written as:
Arc Method
Where,
QX= Initial Quantity of –X
=Change in quantity demanded for -X
PY= Initial Price of –Y
=Change in price of -Y
Arc Method
• If we calculate cross elasticity as coefficient of
demand between two points on a demand curve
is called arc method. This method is used when
there are large change in Price of one good and
quantity demanded for others related goods.
• The formula for measuring cross elasticity of
demand at the middle point of the arc on the
demand curve is written as:
Arc Method
• Symbolically,
Where,
ES=Price elasticity of supply Qs= Initial Quantity
supplied
Qs= Change in quantity supplied P= Initial Price
Types of Elasticity of supply
Elasticity of supply is classified in to five parts as
pointed:
• Perfectly Elastic Supply (ES=∞)
• Perfectly Inelastic Supply(ES=0)
• Unitary Elastic Supply(ES=1)
• Relatively elastic Supply(ES>1)
• Relatively Inelastic Supply(ES<1)
1. Perfectly Elastic Supply
If the quantity supplied of a commodity infinitively
change due to negligible change in price of
commodity is known as perfectly elastic supply. Its
supply curve will be parallel to a horizontal straight
line given at the price. In symbolically it can be
written as:
ES=∞
2. Perfectly inelastic supply
If the quantity supplied of a commodity dose not
change with respect to change in price of
commodity is known as perfectly inelastic supply.
Its supply curve will be parallel to a vertical straight
line showing constant supply at any price. In
symbolically it can be written as:
ES=0
3. Unitary elastic Supply
If the percentage quantity supplied of a commodity
is equal to the percentage change in its price, the
supply of the commodity is known as unitary
elastic supply. It means the quantity supplied
changes proportionately to the proportionate
change in its price. Symbolically it can be express
as:
ES=1
4. Relatively elastic Supply
If the small change in price leads to large change
in quantity, then the supply is said to be relatively
elastic supply. i.e. the percentage change in
quantity supplied of a commodity is more than the
percentage change in its price, the supply of the
commodity is known as relatively elastic supply.
Symbolically it can be express as:
ES>1
5. Relatively inelastic Supply
If the large change in price leads to small change
in quantity, then the supply is said to be relatively
inelastic supply. i.e. the percentage change in
quantity supplied of a commodity is less than the
percentage change in its price, the supply of the
commodity is known as relatively inelastic supply.
Symbolically it can be express as:
ES<1
Measurement of Price elasticity of supply
There are three method of measuring the elasticity of
supply:
1. Percentage method:
In this method, Esis measure the percentage change in
the quantity supplied of a commodity with respect to
percentage change in its price.
• Symbolically,
Where,
ES=Price elasticity of supply Qs= Initial Quantity supplied
Qs= Change in quantity suppliedP= Initial Price
2. Arc method
• If we calculate elasticity of supply as coefficient of
supply between two points on a supply curve is
called arc method. This method is used when
there are large change in price and quantity
supplied.
• The formula for measuring elasticity of supply at
the middle point of the arc on the supply curve is
written as:
2. Arc method
• In symbolically
Where,
QS1= Initial Quantity supplied QS1= New Quantity supplied
=Change in quantity Supplied
P1= Initial Price P2= new Price
=Change in price
2. Arc method
• In symbolically
Where,
QS1= Initial Quantity supplied QS1= New Quantity supplied
=Change in quantity Supplied
P1= Initial Price P2= new Price
=Change in price
3. Point method
The point method is used to measure the elasticity of
supply at a single point of the supply curve. It is
measure of the proportion change in quantity supplied
in response to a very small change in price. According
to this method the elasticity of supply is given by